Investors not acting in their own best interest, says State Street study

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In an investment environment of heightened uncertainty, retail and institutional investors are exhibiting behaviour that appears to be at odds with their investment goals, according to a study by the State Street Center for Applied Research.

The study, entitled The Influential Investor: How Investor Behavior is Redefining Performance, was based on 12 months of research and input from more than 3,300 investment management industry participants.

Among the study’s primary findings is that, investors are not acting in their best interests as they are becoming more aware of economic instability and misaligned interests amongst investment providers, government and markets. As a result, their investment decisions do not always align with their stated goals and there is ample aggregate evidence of this behaviour.

Institutional investors are faced with challenges in navigating the complexity of certain asset classes. Low-yield markets have increased institutional investors’ appetite for alternative strategies. Yet, the majority admits their greatest challenge is not having a deep enough understanding of these assets.

Retail investors’ conservative strategies are cracking their retirement nest eggs. When retail investors were asked what steps needed to be taken over the next ten years to retire, the majority said to invest more aggressively, yet cash is their number one allocation now and is expected to remain number one over the next decade.

Kelly McKenna, global head of the State Street Center for Applied Research, says: “While investors have never been as aware of their micro and macro environments, they are exhibiting behaviours that are divorced from their stated investment objectives.”

Against this backdrop of investor disconnect between behaviour and goals, the study found that investors identified performance as the most important metric for determining the value of their investment providers as well as the greatest weakness of their investment providers.

Accordingly, the study revealed that when it comes to performance, one size no longer fits all.

“Current monolithic benchmarks based on relative performance to peer groups or indices serve the provider,” says Suzanne Duncan, global head of research for the Center for Applied Research. “The investor’s view of value is now more complex and reflects his/her own personal blend of strategies and objectives. In today’s investment reality, the investor is the benchmark when it comes to defining performance.”

Based on these findings, the Center for Applied Research advocates for fully transparent performance models that focus on long-term sustainability of returns, defined in terms of value to the investor. Over time, this new model will help to reduce barriers to healthy decision-making and will lead to improved performance.

The study also found that investors’ seemingly irrational behaviour is actually a rational response to a number of factors impacting the current global investment environment:

• Major economic trends, including a steady increase of national debt worldwide, tighter correlations across global markets, and a rise in systemic risk;

• Mistrust of their primary investment provider to act in their best interest, stemming in part from lack of value delivered versus fees charged. Only one-third of investors believe their primary investment provider is acting in their best interest; and

• Impediments from politics as well as new financial regulation that most investors believe will be ineffective and expensive. Sixty four per cent of investors believe that regulation will not help address current problems and 62 per cent believe the cost will be passed on to them.

The Center for Applied Research proposes a four-component performance model in which key value drivers become the building blocks for “personal” performance. Two components - alpha seeking/beta generation and downside protection - are related to market forces and are common to most investors. The other two components – liability management and income management – are risk exposures unique to each investor.

McKenna says: “While the future of the industry will be determined by the actions investors take, the investment community has clear opportunities to work together to create better solutions for this new economy.”